It's an experiment at this point.

Photographer: Justin Sullivan/Getty Images

California Tests the Old Free-Market Maxims

Noah Smith is a Bloomberg View columnist. He was an assistant professor of finance at Stony Brook University, and he blogs at Noahpinion.
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Conservatives and free-marketers often contrast the Texas model of economic development with the California model. As a Texan who now lives in California, I would like to see both succeed. But in terms of the economics, California’s case is more interesting, because it challenges much of the received wisdom about development policy.

Texas’ strategy is a pretty traditional approach -- low taxes, low regulation and generous access to natural resources. Those are the kind of things that most development economists would recommend, at least in decades gone by. California, on the other hand, has tried an unorthodox mix of industrial policies, designed to make it a leader in the technologies of the future. That’s an approach most economists would probably still warn against. Industrial policy is still very much out of favor in developed-world intellectual circles.

So while Texas is a safe bet, California is an interesting test case. That’s why we need to watch it closely.

A lot of the state’s industrial policy focuses on renewable energy. California has a law requiring that 50 percent of the state’s electricity be generated from carbon-free sources by 2030, and mandates that buildings double their energy efficiency by that time. The Democratic governor, Jerry Brown, has declared a goal of making the state’s carbon emissions 40 percent lower in 2030 than they were in 1990. The ambitious California Solar Initiative ended this year, but a system of tax rebates, grants and subsidies remains for all carbon-free forms of energy.

The California Public Utilities Commission, meanwhile, is pushing for 1.3 gigawatts of energy storage in the state. A raft of new laws and bureaucratic directives is accelerating the drive for energy storage. The new policies will subsidize the creation and adoption of storage technologies, fund specific storage projects in locations chosen by the state, and create legal processes to help utilities connect their storage systems.

These are exactly the kind of programs that cause free-marketers to recoil. But free-market theory doesn’t always hold the keys to eternal truth. The question is: Will California’s energy-focused industrial policy work? And how will we know?

QuickTake Wind Power
One measure is the cost of electricity -- California’s costs are high, but not the highest. But that cost includes subsidies, which are paid out of tax revenue, and California taxes are also high. Meeting all those green energy mandates might be taking a toll on the state’s economy.

California’s economy looks OK right now. The state’s employment rate is lower than the country’s as a whole, but that has been true for decades. The gap is no bigger than in the 1990s:

Nothing Disastrous Here
Employment-to-population ratio
 
Source: Federal Reserve Bank of St. Louis

So far, there are no signs that the industrial policy has changed the state’s fundamental economic condition one way or another. Of course, this is a very casual, informal analysis -- a real economic study would have to look very carefully at the timing of the policies, and the level of California employment relative to similar regions before and after the policy changes. Plenty of other things are going on in the state -- a tech boom, a proposed minimum wage hike and battles over land-use policy. So far, all we know is that industrial policy has neither wrecked nor supercharged the California economy.

What other results might we expect to see? Industrial clustering is something to watch. A lot of economic research supports the idea that industries like to clump together in a single area -- witness Silicon Valley’s dominance of information technology, or Detroit’s lead in automotive industries. What about green energy and storage tech?

Here, the policy seems at first glance to be succeeding. California is judged as the leader in clean tech. But is this a durable advantage, or a temporary rush for subsidy handouts? And how is the state doing against its real competitors -- Asian countries like China and South Korea, whose subsidies are also substantial?

Tesla, a giant in the battery and electric vehicle spaces, is headquartered in California, though its so-called gigafactory is in neighboring Nevada. If it survives and thrives, Tesla will no doubt serve as an anchor company for many smaller businesses in the industry. The Bay Area is home to many energy storage and clean-tech startups, though this may be due more to its concentration of engineers and venture capitalists than state policy initiatives. Meanwhile, in this globalized age, companies that get their start in California can easily move their operations to China once they attain sufficient scale.

So the jury is still out on California’s experiment. If the state manages to convert to carbon-free energy without wrecking its economy in the process, and if it succeeds in becoming a green-energy hub the way it became the center for IT, then free-marketers will have reason to doubt their typical nostrums. But if the subsidies and mandates send costs soaring and employment spiking, or if the state loses industrial leadership in clean tech, the experiment will have failed. The world is watching.

(Corrects graph comparing California and U.S. employment-to-population rates.)

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story:
Noah Smith at nsmith150@bloomberg.net

To contact the editor responsible for this story:
James Greiff at jgreiff@bloomberg.net